Textbook Problem

Jackson, Inc., manufactures motorcycles. Jackson produces all the components necessary for the production of the cycles except for one (a carburetor). This component is purchased from two local suppliers: Harvey Parts and Curtis, Inc. Harvey sells the component for $64 per unit, while Curtis sells the same component for $57. Because of the lower price, Jackson purchases 75 percent of its components from Curtis. Jackson purchases the remaining 25 percent from Harvey to ensure an alternative source. The total annual demand is 160,000 carburetors.

Harvey’s sales manager is pushing Jackson to purchase more of its units, arguing that its component is of much higher quality and so should prove to be less costly than Curtis’s lower-quality component. Harvey has sufficient capacity to supply all the carburetors needed and is asking for a long-term contract. With a five-year contract for 120,000 or more units, Harvey will sell the component for $60 per unit with a contractual provision for an annual product-specific inflationary adjustment. Jackson’s purchasing manager is intrigued by the offer and wonders if the higher-quality carburetor actually does cost less than the lower-quality Curtis carburetor. To help assess the cost effect of the two products, the following data were collected for quality-related activities and suppliers:

1. I. Activity data:

1. II. Supplier data:

*The Quality Control Department indicates that sampling inspection for the Harvey component has been reduced because the reject rate is so low.

Required:

1. 1. Calculate the cost per component for each supplier, taking into consideration the costs of the quality-related activities and using the current prices and sales volume. Given this information, what do you think the purchasing manager ought to do? Explain.
2. 2. Suppose the Quality Control Department estimates that the company loses $3,300,000 in sales per year because of the reputation effect of defective units attributable to failed components. What information would you like to have to assign this cost to each supplier? Suppose that you had to assign the cost of lost sales to each supplier using one of the drivers already listed. Which would you choose? Using this driver, calculate the change in the cost of the Curtis carburetor attributable to lost sales.